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I highly recommend that readers view the debate (or the transcript) between the above participants that Reason held last October but has just given renewed prominence at Reasononline and in their July 2008 print edition.

Fred L. Smith, Jr. is the President and Founder of the Competitive Enterprise Institute (which published Bailey’s 2002 Global Warming and Other Eco-Myth book).

Lynne Kiesling is an expert on the regulation of electric power generation and distribution, Senior Lecturer in Economics at Northwestern University, and former director of economic policy at the Reason Foundation.

Below I excerpt what I consider the key remarks of each participant:

Lynne Kiesling:

From an economic perspective, the problem of climate change is twofold. First, there are incomplete and uncertain property rights in the air. It’s ludicrous to imagine us each walking around with a bubble over our heads so that we can only breathe and use the privatized air sphere around us. Second, there’s a large number of affected parties … some would argue the entire planet is affected.

When a common-pool resource is shared by millions of diverse individuals, defining the use rights over that resource is really hard and costly. This is the kind of situation in which decentralized market processes have trouble even emerging. In this imperfect world, we’re considering two imperfect alternative policies: a carbon tax and cap and trade.

Our experience with common-pool resources, ranging from agreements to share the team of oxen in the medieval village to the development of the sulfur dioxide acid rain program in the 1990s, tells us that effective policy focuses on reducing transaction costs and better defining property rights so that private parties can engage in mutually beneficial exchange. That’s the logic behind the carbon cap-and-trade policy.

Like all policies in such a complex area, it’s got problems itself. How do you allocate carbon permits? There’s the knowledge problem: How do we know how many carbon permits is the right number? Also, as a policy instrument, it’s prone to political manipulation. Electric utilities are already seriously jockeying to make sure they’re playing a part in getting the rules written and that they’re involved in determining the allocation mechanisms if such a policy comes into place.

Another problem is that unlike with sulfur dioxide, the likely participants are really heterogeneous. When we were dealing with sulfur dioxide, it was mostly large-scale central-generation power plants, a pretty homogeneous bunch.

A carbon tax is also prone to some of these problems, particularly the knowledge problem and the political manipulation problem. The benefits to a permit market that have been shown in other situations are that defining property rights and reducing transaction costs does a better job of taking advantage of diffuse private knowledge. It’s also more likely to induce the process that’s at the foundation of economic growth, which is innovation. So I tend to come down on the side of cap and trade, although it’s not a ringing endorsement. …

Finally, I think most people fail to realize that the abysmal job we do of pricing electricity contributes substantially to our energy use. The only resources that are priced as badly as electricity in our economy are highways and water.

Retail competition and choice for consumers would increase the offering of time-differentiated dynamic pricing, which shifts resource and electricity use across time. Research shows that this promotes conservation and more efficient use of electricity, increases offerings of green power to consumers who want to choose a green power option, and increases the incentives to develop and adopt technologies, such as price-responsive appliances, that enable private individuals to control their own energy use.

So the message from me is this: It’s a complicated, imperfect world, and the policies we can adopt that induce innovation and harness diffuse private knowledge will be the most effective for this long-term problem.

Ronald Bailey:

Before we began this session, Fred Smith asked me would it be all right if he referred to me as a commie symp. … I stand before you as somebody who’s been reporting and writing on environmental issues for over 20 years. To the extent that I’m known at all, I’ve been known as someone very skeptical of all kinds of environmentalist dooms. My first book was called Ecoscam: The False Prophets of Ecological Apocalypse. It pains me to have concluded, following the scientific data, that one of the dooms is a real problem.

As Lynne very ably pointed out, one of the problems with global warming is that it exists in a commons—that means the atmosphere is very hard to divide up and make into private property.

When you have an environmental commons, we typically have two ways of handling that problem. One is that we privatize it. In many environmental issues, we’re moving in that direction. Fisheries, for example, are being privatized. Forests are being privatized. Water resources can be privatized as well.

The problem with air pollution—and global warming is a form of air pollution—is that I don’t see a good, easy way to privatize it. The transaction costs are too large. And if you can’t privatize it, you have to regulate it. So now the question is: What’s the least bad way to regulate? And that is why I’ve come out in favor of a carbon tax.

As a good libertarian, I thought I would like cap and trade. The problem is I’ve been watching the European attempt to do this, and it’s a complete disaster. The governments, not surprisingly, cheat constantly. Their carbon market collapsed a year ago because the governments allocated more permits for carbon emissions than were necessary to cover what was being emitted, so naturally the price went to zero. And if the Europeans can’t pull this off, how could you expect the world to pull this off?

I understand the diffuse knowledge problem—how markets can and, in fact, do marshal that kind of information in very good ways. The problem is that there’s no baseline for the rest of the world. … So I come out in favor of the tax because you have a baseline. You have a way of internationally monitoring that. The baseline is a zero tax and from that, you can build up. You could start the tax low and, as you gain more information about what the atmosphere is likely to do, you could adjust the tax over that time.

For consumers, for inventors, for innovators, a tax offers price stability in a way that the cap-and-trade markets don’t. …

I, against my values, have decided that this is a problem. I would really like to be persuaded that classical liberalism and markets and so forth have a way of solving this problem. I’m still waiting for Fred’s proposal. I don’t think it can be done voluntarily around the world. The voluntary carbon markets are tiny— … And if you don’t have an economic incentive to participate in those carbon markets, like a tax or like a cap-and-trade permit, most people aren’t going to do it. Why would they? Why would they spend money that they don’t have to spend? …

Basically it would be a globally harmonized tax, but the money would be collected by each country and spent by the governments in each country. In the ideal world, you would recycle that money by reducing other taxes, so the overall tax level in the country would not increase. What you would be doing is incentivizing people to conserve energy but also incentivizing people to innovate, to find new ways to produce energy that people would want using low-carbon technologies or carbon-sequestering technologies. …

Government does not innovate. So by creating a carbon tax you would encourage private people to marshal the information in response. So carbon tax is a price, to figure out better ways to make energy, low-carbon energy. I don’t know what those energies will be. I’m sure the government doesn’t know either, and I don’t want them wasting the money doing it.

Fred L. Smith:

What’s the best way of addressing whatever risks there are in global warming? Should the risk of catastrophic global warming justify abandoning our general preference for freedom over coercion? Should we free market advocates champion carbon taxes or carbon rationing, some form of suppressing energy use, or should we favor economic liberalization? …

There is evidence that there has been some warming, moderate amounts, but the idea that we’re facing imminent catastrophe has weakened. Our ability to do anything about CO2 increases for the next half-century is now obviously nonexistent. And the tensions we could create by pushing the world into some form of energy rationing, I think, are underestimated. Recall that in World War II, one of the incidents that pushed the war party into power in Japan was an energy boycott on that Asian nation. We are going to do that again with China. It doesn’t make a lot of sense to me.

Shouldn’t we be asking whether the risks of global warming are more or less than the risk of global warming policies?

The costs of energy rationing are not trivial. Energy is what makes it possible to have mobility, to have labor-saving technology, to have lives that are comfortable, to have hope for the future. Energy rationing would lead to slower economic and technological growth, a darker, less human-friendly world. The trillions we’re talking about spending over the next generations on global warming could go to much better causes, could save lives and inspire hopes today.

But we’ve been told—we’ve heard it from Ron, at least—that we must do something. Perhaps. But why must that something be the expansion of state power over our lives? Why do we limit ourselves to taxes or rationing? There are other alternatives out there.

We could do some more R&D. We could mitigate. What about mirrors in space? What about fertilizing the oceans? Those of us who have looked at NASA and so forth are not overly enamored with government’s ability to underwrite those kind of policies, but we should be equally optimistic about government’s attempt to tax in this academic-blackboard economic way.

Resiliency is what we should be talking about. Not whether taxes or quotas are the better way to suppress freedom, but how we can use the global warming concerns to advance an agenda of freedom. How do we find ways of accelerating economic and technological progress? How do we liberalize the economies of the world? How do we expand the institutions of liberty even into the air sheds?

We can free biotechnology. I’m sure Ron and I both agree with that. If the world is hotter, colder, wetter, drier, we’re going to need the ability to modify our crops much more than we have today. Freeing biotechnology from the regulatory straitjacket it’s in today would be a way of doing that.

As Lynne said, we could complete the job of freeing our electricity system, not just for pricing electricity but also for incentivizing the grid to be smarter and more robust so we can free the trapped electricity that sits idle throughout America. Move fire, storm, and other insurance out of the government subsidy range and put it back into the private sector so we can guide people away from living in high-risk areas.

Unilateral free trade. Extend property rights to water. Liberalize energy exploration. Cuba can drill off the coast of Florida; why can’t America? Where is nuclear power? Certainly Al Gore hasn’t mentioned it. Eliminate the corporate income tax. Accelerate the turnover of capital goods and equipment. That would mean a much more efficient world to live in. …

Today, fears about global warming are pushing the world towards disaster. This time the threat is not just to the lamps of Europe but to the lamps of the world. Energy suppression, if it happens, might last for many lifetimes. …

I have one strong procedural difference with both Ron and Lynne on this. The argument is that when you have a common property resource, your choices are either to privatize that resource, move towards institutions of liberty, or politicize it in some enlightened way as Lynne and Ron have talked about. But Ronald Coase said there’s always a third option, that the costs of transaction in that area are much higher than the failure to have transaction in that area and therefore we should allow evolution to proceed and see what creative solutions emerge. That is basically what we should be doing in the global warming area.

Bailey: So, Fred, are you saying that human beings are not clever enough to come up with low-carbon energy?Smith: I’m saying that technocratic social engineering projects aren’t the best way to free the creative energies of mankind.Bailey: Unfortunately, Fred, you haven’t shown a path for evolution to this. I’m sorry. I realize that you believe that somehow the invisible hand will take care of a commons problem always, but commons problems are solved by creating property.Smith: Government.Bailey: And the government helps create property, defends property. It’s an institution. It’s not a great institution. Right now all the big emitters are coming to Washington and begging for free permits so they can get tons of money, basically, and extract it from our pockets—which is another reason I don’t like cap-and-trade systems. They want the government to create an asset for them worth hundreds of billions of dollars.